Note 5 -Fair Value of Financial Instruments

Our valuation techniques for financial instruments use observable and unobservable inputs. Observable inputs reflect readily obtainable data from third party sources, while unobservable inputs reflect management’s market assumptions. The Accounting Standards Codification Topic No. 820, “Fair Value Measurement,” classifies these inputs into the following hierarchy:

Level 1 Inputs - Quoted prices for identical instruments in active markets.

Level 2 Inputs - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 Inputs - Prices determined using significant unobservable inputs. Unobservable inputs may be used in situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period). Unobservable inputs reflect management’s assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available.

The following describes the valuation methodologies used for our assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy. Any transfers between levels are assumed to occur at the beginning of the reporting period.

Cash - Cash includes cash on deposit with financial institutions. The carrying amount of cash is deemed to be its fair value and is classified as Level 1. Cash balances posted by us to counterparties or posted by counterparties to us as collateral are classified as Level 2 because they are integrally related to the Company's repurchase financing and interest rate swap agreements, which are classified as Level 2.

Agency Securities, Available for Sale - Fair value for the Agency Securities in our MBS portfolio is based on obtaining a valuation for each Agency Security from third party pricing services and/or dealer quotes. The third party pricing services use common market pricing methods that may include pricing models that may incorporate such factors as coupons, prepayment speeds, spread to the Treasury curves and interest rate swap curves, duration, periodic and life caps and credit enhancement. If the fair value of an Agency Security is not available from the third party pricing services or such data appears unreliable, we obtain pricing indications from up to three dealers who make markets in similar Agency Securities. Management reviews pricing used to ensure that current market conditions are properly reflected. This review includes, but is not limited to, comparisons of similar market transactions or alternative third party pricing services, dealer pricing indications and comparisons to a third party pricing model. Fair values obtained from the third party pricing services for similar instruments are classified as Level 2 securities if the inputs to the pricing models used are consistent with the Level 2 definition. If quoted prices for a security are not reasonably available from the third party pricing service, but dealer pricing indications are, the security will be classified as a Level 2 security. If neither is available, management will determine the fair value based on characteristics of the security that we receive from the issuer and based on available market information and classify it as a Level 3 security. At March 31, 2016 and December 31, 2015, all of our Agency Security fair values are classified as Level 2 based on the inputs used by our third party pricing services and dealer quotes.

Non-Agency Securities Trading - The fair value for the Non-Agency Securities in our MBS portfolio is based on estimates prepared by our Portfolio Management group, which organizationally reports to our Chief Investment Officer. In preparing the estimates, our Portfolio Management group uses commercially available and proprietary models and data as well as market intelligence gained from discussions with, and transactions by, other market participants. We estimate the fair value of our Non-Agency Securities by estimating the future cash flows for each Non-Agency Security and then discounting those cash flows based on our estimates of current market yield for each individual security. Our estimates for future cash flows and current market yields incorporate such factors as collateral type, bond structure and priority of payments, coupons, prepayment speeds, defaults, delinquencies and severities. Quarterly, we compare our estimates of fair value of our Non-Agency Securities with pricing from third party pricing services, dealer marks received and recent purchase and financing transaction history to validate our assumptions of cash flow and market yield and calibrate our models. Fair values calculated in this manner are considered Level 3. During the quarter ended March 31, 2016, we began to invest in Non-Agency Securities. At March 31, 2016 all of our Non-Agency Security fair values are calculated in this manner and therefore were classified as Level 3.

Receivables and Payables for Unsettled Sales and Purchases - The carrying amount is generally deemed to be fair value because of the relatively short time to settlement. Such receivables and payables are classified as Level 2 because they are effectively secured by the related securities and could potentially be subject to counterparty credit considerations.

Repurchase Agreements - The fair value of repurchase agreements reflects the present value of the contractual cash flows discounted at the estimated LIBOR based market interest rates at the valuation date for repurchase agreements with a term equivalent to the remaining term to interest rate repricing, which may be at maturity, of our repurchase agreements. The fair value of the repurchase agreements approximates their carrying amount due to the short-term nature of these financial instruments. Our repurchase agreements are classified as Level 2.

Obligations to Return Securities Received as Collateral - The fair value of the obligations to return securities received as collateral are based upon the prices of the related U.S. Treasury Securities obtained from a third party pricing service. Such obligations are classified as Level 1.

Derivative Transactions - Our Futures Contracts are traded on the Chicago Mercantile Exchange (“CME”) and are classified as Level 1. The fair values of our interest rate swap contracts, interest rate swaptions and basis swaps are valued using third party pricing services that incorporate common market pricing methods that may include current interest rate curves, forward interest rate curves and market spreads to interest rate curves. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities. Management compares pricing used to dealer quotes to ensure that the current market conditions are properly reflected. The fair values of our interest rate swap contracts, interest rate swaptions, basis swap contracts and TBA Agency Securities are classified as Level 2.

The following tables provide a summary of our assets and liabilities that are measured at fair value on a recurring basis at March 31, 2016 and December 31, 2015.



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at March 31, 2016
Assets at Fair Value:
Agency Securities, available for sale	$	—	$	10,474,010	$	—	$	10,474,010
Non-Agency Securities, trading	$	—	$	—	$	285,696	$	285,696
Derivatives	$	—	$	1,665	$	—	$	1,665
Liabilities at Fair Value:
Derivatives	$	—	$	298,685	$	—	$	298,685

There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the quarter ended March 31, 2016.



	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at December 31, 2015
Assets at Fair Value:
Agency Securities, available for sale	$	—	$	12,461,556	$	—	$	12,461,556
Derivatives	$	—	$	999	$	—	$	999
Liabilities at Fair Value:
Derivatives	$	—	$	233,301	$	—	$	233,301

There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the year ended December 31, 2015.

The following tables provide a summary of the carrying values and fair values of our financial assets and liabilities not carried at fair value but for which fair value is required to be disclosed at March 31, 2016 and December 31, 2015.



March 31, 2016					Fair Value Measurements using:
	Carrying Value		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets:
Cash	$	243,294	$	243,294	$	243,294	$	—	$	—
Cash collateral posted to counterparties	$	306,104	$	306,104	$	—	$	306,104	$	—
Accrued interest receivable	$	28,883	$	28,883	$	—	$	28,883	$	—
Financial Liabilities:
Repurchase agreements	$	9,923,859	$	9,923,859	$	—	$	9,923,859	$	—
Payable for unsettled purchases	$	14,955	$	14,955	$	—	$	14,955	$	—
Accrued interest payable- repurchase agreements	$	6,255	$	6,255	$	—	$	6,255	$	—



December 31, 2015					Fair Value Measurements using:
	Carrying Value		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial Assets:
Cash	$	289,925	$	289,925	$	289,925	$	—	$	—
Cash collateral posted to counterparties	$	263,799	$	263,799	$	—	$	263,799	$	—
Principal payments receivable	$	37	$	37	$	—	$	37	$	—
Accrued interest receivable	$	34,500	$	34,500	$	—	$	34,500	$	—
Financial Liabilities:
Repurchase agreements	$	11,570,481	$	11,570,481	$	—	$	11,570,481	$	—
Accrued interest payable- repurchase agreements	$	7,724	$	7,724	$	—	$	7,724	$	—

The following table provides a summary of the changes in Level 3 assets measured at fair value on a recurring basis at March 31, 2016. We did not have Level 3 assets at December 31, 2015.



	For the Quarter Ended
Non-Agency Securities	March 31, 2016
Balance, beginning of period	$	—
Purchases of Non-Agency Securities, at cost	281,755
Gain on Non-Agency Securities	4,122
Discount accretion	(181		)
Balance, end of period	$	285,696
Gain on Non-Agency Securities	$	4,122

The significant unobservable inputs used in the fair value measurement of our Level 3 Non-Agency Securities include assumptions for underlying loan collateral, cumulative default rates and loss severities in the event of default, as well as discount rates.

The following table presents the range of our estimates of cumulative default and loss severities, together with the discount rates implicit in our Level 3 Non-Agency Security fair values at March 31, 2016. We did not have Level 3 assets at December 31, 2015.

March 31, 2016



Unobservable Level 3 Input	Minimum		Weighted Average		Maximum
Cumulative default	0.00	%	0.00	%	0.00	%
Loss severity (life)	0.00	%	62.99	%	100.00	%
Discount rate	4.96	%	5.62	%	6.35	%
Delinquency (life)	0.00	%	0.87	%	2.60	%
Voluntary prepayments (life)	9.11	%	14.73	%	24.05	%

The table above include the effects of the structural elements of our Non-Agency Securities, such as subordination and over collateralization or insurance. Significant increases or decreases in any of these inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, a change in the assumption used for the probability of cumulative default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for voluntary prepayment rates for the life of the security. However, given the interrelationship between loss estimates and the discount rate, overall Non-Agency Security market conditions would likely have a more significant impact on our Level 3 fair values than changes in any one unobservable input.